Article

As part of the contract, the parties agreed that "[i]f [Applicant] gave notice to terminate under [contract clauses] the [Beneficiary] undertook an obligation to return the stand-by letter of credit, cancelled and undrawn, and to reimburse to [Applicant] on demand all expenses including without limitation bank fees and legal fees in relation to the issuance of the stand-by letter of credit." A separate clause in the contract provided that Beneficiary would reimburse Applicant for the cost of having the LC confirmed at the time the first aircraft was delivered. Also in the contract was an agreement that Beneficiary would not "negotiate" the LC to any third party without the prior written consent of Applicant. The contract also included a clause setting terms for liquidated damages if Beneficiary did not perform as well as a set amount toward the payment of legal costs.

Despite multiple extensions of the deadlines for delivery, Beneficiary failed to perform its obligations, and did not deliver any of the five aircraft. After discussing the correspondence trail at length, the court said that "the pattern of broken promises continued and that [Beneficiary] was unable to provide any documentary evidence that it had purchased a single aircraft for the purpose of fulfilling its contractual obligations [to Applicant]. Effectively, the discussions broke down." Following this breakdown, Applicant served Beneficiary with a notice of termination pursuant to language in the lease agreements, and demanded the return of the LC, "cancelled and undrawn."

In the interim between issuance of the LC and the demand for its return, Beneficiary's president arranged to have the LC transferred from Issuer to US Nation Financial Group, with Confirming Bank arranging for the transaction. Beneficiary's president sent a letter to Applicant's director outlining the transfer of the LC and informed him that a "minor" amendment needed to be made to the LC as follows, "'[c]hange the drawing statement from 'Amount due to us by the applicant as of the date of this claim' to 'Amount due to us as of the date of this claim'.'" The court states that "was a surprising request, because of course it could have the effect of converting the letter of credit into an open-ended instrument on which a third party unconnected with either [Applicant] or the lease transactions could claim." Applicant's counsel made this concern clear in a letter "indicating that the proposed amendment was not acceptable as it would expose [Applicant] to the risk that any third party could claim under the letter of credit for amounts owed to it by [Beneficiary] or another entity, even if [Applicant] did now owe anything." The letter went on to state that the transfer of the LC to US Nation Financial Group was a "'contravention of the terms of the aircraft lease agreements ... which provide that [Beneficiary] shall not negotiate the letter of credit to any third party without the prior written consent of [Applicant], and also that the letter of credit is provided solely as security for the payment obligations ... under the lease agreement and may not be used for any other purpose.'" [The opinion discusses the limitation on transferability in the contract, but does not mention any limiting language in the LC itself].

Following the notice of termination, Applicant filed this suit seeking liquidated damages and legal costs pursuant to the lease agreement; the cost of opening and confirming the LC, or in the alternative, the cost of having the LC confirmed; and damages for the loss suffered as a result of the wrongful transfer of the LC.

In his witness statement to the court, Beneficiary's managing director acknowledged that the LC was transferred without Applicant's consent. He stated it was transferred in order to raise capital quickly for Beneficiary so that it could obtain aircraft being sold at that time by a third party, and since it was not possible to obtain a speedy consent from Applicant at the time, Beneficiary believed Applicant "would provide consent retrospectively as [Beneficiary] believed that the transfer would result in the supply of the aircraft."

Following its transfer, the LC was the object of "serious criminal conduct," when Mr. Tameo, an unrelated third party, fraudulent assumed control of the LC. According to testimony of Beneficiary's managing director, Mr. Tameo "held himself out to be a representative of US Nation, [he] was in due course arrested by the FBI ... the letter of credit was recovered, in circumstances in which Mr. Tameo was attempting dishonestly to draw down $1.2 million under the credit and to use the credit to purchase a company in Peru." Mr. Tameo later pled guilty to a charge of fraud and was sentenced to 25 months in prison in the United States.

The court did not find Beneficiary was a party to the fraudulent behavior of Mr. Tameo, but that it did breach its contract with Applicant by transferring the LC without Applicant's consent, as the contract required. The court went on to state that while Mr. Tameo's actions were a "particularly gross example of the sort of abuse to which a letter of credit is particularly prone, [it] is nonetheless something ... the restriction on negotiation [in the contract] is expressly designed to eliminate, in the sense of eliminating the risk of making the letter of credit effectively a negotiable document capable of being used by third parties unconnected to the transaction for which it was posted as security."

Noting that the contract between the two parties may have been the result of "hard bargaining," but did not "come even close to oppression," as the Beneficiary alleged, the Queen's Bench Division (Commercial Court), Tomlinson, J., granted Applicant's motion for summary judgment, awarding the Applicant US$5,550,500 in liquidated damages, US$154,400 as the cost of issuing the confirmed LC, US$10,000 as contribution toward legal costs, and US$50,000 as an interim payment of damages for the wrongful transfer of the LC.

Comment: While the court is correct in its observation that a negotiable credit is dangerous, the structure of this transaction is puzzling. The credit did not need to be issued in a negotiable form nor did it need to be transferable. Absent nomination of a negotiating bank or an express provision that the credit is transferable, it would be straight and non transferable. Rather than providing for protections in the contract with the beneficiary, the applicant would have done better to require that the credit be issued in a manner that protected it.

While the opinion is not clear on these points, it is likely that the beneficiary effected a transfer or assignment under contract law rather than LC law and practice. In effect, the transferee would not be able to draw on the LC because it is not the beneficiary or transferee beneficiary. If, on the other hand, the credit was freely transferable, then the applicant has assumed the risk that it will be transferred.

[JEB/fkd]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.